Monday, February 12, 2018

Lesson #288: How to Build a Startup Ecosystem

Posted By: George Deeb - 2/12/2018

I have previously written about Chicago’s exploding startup ecosystem .  But, startup ecosystems are popping up all across the country a...



I have previously written about Chicago’s exploding startup ecosystem.  But, startup ecosystems are popping up all across the country and the world, with varying levels of success.  I wanted to talk about the mix of ingredients that are needed to make a startup ecosystem thrive over time.  So, leaders in your local communities can have a blueprint with which to follow to propel your startup ecosystem, and hopefully, your own success in the process.

THE MOST IMPORTANT INGREDIENTS

Access to Great Ideas.  Great ideas turn into great businesses.  Think building “platforms” over “features”, or “wisdom” over “widgets”, or “painkillers” over “vitamins”.  Startups are hard in all cases, might as well be working on really big ideas.

Access to Talent.  Great entrepreneurs, preferably serial entrepreneurs that have learned from prior mistakes, are ultimately going to dictate the success of their businesses, and in turn, the success of the ecosystem.

Access to Capital.  The best ideas and the best talent are useless without the capital to fund their vision.  If that capital is local, great, as investors like to invest close to home.  If that capital is located in another city, that is also great, provided investors in those towns are willing to deal with travel (which they often don’t).  It is critical that the capital is available to embrace each stage of development, from seed to early to growth stages of your business.  Having seed stage, but not Series A or Series B stage, is a recipe for a likely “flame-out” of that startup, when they hit the wall in that level of their growth.

Access to Customers.  To me, this is the most important piece.  Customers drive revenues.  Revenues impress investors.  Investors fund growth.  Growth leads to big exits.  Big exits leads to a robust ecosystem.  This often means tight partnerships between early stage ideas with later stage companies to buy those services (ones who are supportive to helping the local startup community).

THE KEY PLAYERS

Entrepreneurs.  Duh, you need experienced teams running the startup businesses.  With an equal balance of needed skillsets from strategy, to marketing, to technology, etc.

Mentors.  First time entrepreneurs need to be able to ask questions of experienced leaders, to help get them up the learning curve, without making the same mistakes of their predecessors.

Investors.  Whether these are individual angels, organized angel networks, venture capital firms, private equity firms, family offices, corporations or other funding sources doesn’t matter.  What matters is the money is flowing from whoever can cut the checks for that stage of a business’s growth.

Incubators.  This category picks up everything from shared office spaces for startups, all the way up to formal startup accelerator programs with formal educational curriculum.  The point is, entrepreneurs can learn from each other, when they are in close proximity to each other.

Universities.  A lot of the biggest business ideas are born from the research inside of universities.  Having a healthy technology transfer process for these ideas to be monetized by business leaders is key.  And, university professors need to know, it is perfectly acceptable to try and monetize their ideas, at the same time they are trying to win a Nobel prize (which many don’t agree with).

Corporations.  The big companies in town help in many ways.  They invest through corporate venture capital funds.  They become potential customers of new local startups.  They have pain points of their own, that a local startup can build and solve for them.  They are often the exit for startups that have gotten large in size. You need a really healthy interaction between the startups and corporations working towards a common goal.

Associations/Events.  There are many groups in town that help organize and propel the ecosystem.  This could be industry trade associations, venture capital associations, entrepreneur networking groups, chambers of commerce, economic development groups, etc.  Leverage these groups of like-minded people at their big annual events or leverage their tools (e.g., job boards on their websites).

Government.  Whether it is at the city, county or state level, your local government can play a very important role.  That could include providing tax incentives for startups to launch in their city, tax free profits on any capital gains in a startup (to help stimulate investment), passing ecosystem friendly laws (like free access to the internet), or establishing venture capital funds with a portion of their treasury.

Service Providers.  The lawyers, accountants, bankers, recruiters, agencies, advisors, and consultants in your community all play a role.  The more experienced they are with startups, the better advice they will bring to the ecosystem.

OPTIMAL OWNERSHIP & ECONOMICS

Spread Equity Deep.  Most entrepreneurs concentrate equity into only a couple people at the top of the organization.  It is better to spread equity deep into other employees, as well.  Why?  Because if employees have a vested interest in the business, they will work harder towards hitting the goal.  And, when the company sells for $1BN, it creates hundreds of multi-millions that have new-found funds to start their next startup, powering the ecosystem to the next level.

Serial Exits.  Selling companies for big returns impress investors.  But, often times a first time entrepreneur, will see a $50MM sale as “big money”, and sell too early to put some cash in the bank for a rainy day.  But, a second or third time entrepreneur has already banked cash from their first exit, and now they are in a position to “roll the dice”, walking from a $50MM sale, in hopes of a $500MM sale down the road.

Reinvest Returns.  Money that simply goes into the bank account, or into safe real estate investments, does not help the ecosystem.  The money needs to round trip back into the community.  So, if you sell for $100MM, hopefully a good chunk of that is funding other startups in the ecosystem.

Shoot for the Moon.  Many investors are simply too conservative for a startup ecosystem to be successful.  Silicon Valley prides itself on “failure as a badge of honor”, as the lessons learned in one bad startup, will apply to the next good startup.  If you are too conservative, trying to cross potential “strikeouts” off your list, you are most likely crossing off potential “home runs” at the same time.

IN GENERAL

It Takes Leadership.  It takes a couple cheerleaders at the top that are going to “plant the flag” and have everyone rally around those goals for the community.  Preferably, somebody that can put their money where their mouth is, and can lean on their deep rolodex of key relationships in your region (e.g., the governor, the mayor, the local billionaires).

Leverage Local Strengths.  Figure out what your region does better than others, and focus your efforts around those industries or skills.  For example, New York would be a great place for financial startups and Los Angeles would be a great place for entertainment related startups, given the high concentration of experts in those areas.

It Requires Startup Density.  It will be really hard to build a robust community in very small towns.  There simply isn’t enough activity, breadth of industries or depth of expertise in any one industry to be effective.  So, either live in a town big enough to support an ecosystem, or prepare for a lot of travel between a bunch of smaller regions that have been aggregated into one community.

Collaborate Across Regions.  Don’t think a startup ecosystem is isolated to your city.  The best startup ecosystems feed off each other.  Think about the collaboration happening between New York and Boston startups, given their close proximity to each.  Or, between Detroit and Germany, because they both serve the auto industry, as examples.

Publicity Helps.  The rest of the country needs to know what you are up to.  Less about your desire to build an ecosystem.  But, more about the venture capital flowing into your region, or big exits being realized at big valuations.  So, celebrate your successes, and put those success stories locally “on display”, or nationally “on the road”.  That will get investors and talent to want to check it out.

Progress Must Be Measured.  Like with any business endeavor, you must have good measurement with which to manage it.  Quantify key metrics like the amount capital raised, investor value created, companies formed, jobs created and material exits in your market, and shoot to have those metrics improve year over year.

It Can’t Be Forced.  The community needs to share a common goal.  The goal of building a robust community can’t simply be embraced by a few, to be forced on others; it has to be embraced by everybody participating in the community, for it to be successful.

It Takes Time.  Don’t expect miracles overnight.  Ecosystems are not built in years, they are built over decades.  That is why Silicon Valley’s startup ecosystem is as big as it is; they have literally been working on it since the 1970’s, a fine tuned machine after 40 years of optimization.


Hopefully, you now have a better understanding of what it takes to build a robust startup ecosystem.  You can’t do it by yourself; you must collaborate as a symbiotic community with a shared set of common goals between people that are equally happy helping others, as they are at helping themselves.  Layout the blue print for your city, let it percolate for a couple decades and hopefully good things will come.


For future posts, please follow me on Twitter at: @georgedeeb.



Friday, February 9, 2018

The Case for Your Startup to Hire Former CEOs

Posted By: George Deeb - 2/09/2018

A common mistake most entrepreneurs make when setting up their management team is filling it with people they feel are easier to contr...



A common mistake most entrepreneurs make when setting up their management team is filling it with people they feel are easier to control or won’t make them look stupid. That typically means an older, former CEO would never get a reasonable look as a direct report to the CEO of most early stage companies. But, is that fear justified?

Read the rest of this post in Entrepreneur, which I guest authored this week.

For future posts, please follow me on Twitter at: @georgedeeb.


Monday, January 29, 2018

Lesson #287: Stop Using Overly Aggressive Marketing Tactics

Posted By: George Deeb - 1/29/2018

Red Rocket has studied over 200 businesses to potentially acquire in the last couple years, and I have seen a lot of questionable market...



Red Rocket has studied over 200 businesses to potentially acquire in the last couple years, and I have seen a lot of questionable marketing tactics being used by a few of these companies, sometimes bordering on outright fraud.  Or, at a minimum, abusing their relationship with their customers, with overly aggressive marketing efforts.  I am going to share a few of these examples with you, so you don't repeat these mistakes with your businesses.  It is hard enough to acquire customers in the first place, yet alone to scare them away long term with tactics like the below.

A CASE STUDY

We were looking at a dropshipping ecommerce business that was marketing a "get a free product if you pay for shipping" offer.  That by itself was fine.  But, when I learned that once the customer was in their shopping cart funnel, buried in the fine print . . . very fine print . . . was a small footnote that said by accepting this offer, they were also signing up for their $39.99 per month subscription model.

We didn't pick up on the problem until we saw that their churn rate of lost customers, was off the charts.  Their average life of a customer subscription was only two months (not 6-10 months, like most good subscription offerings).  This was because customers were getting pissed by seeing $39.99 charges showing up on their credit card, for something they had no idea they had signed up for.  And, to make matters worse, the company made it very difficult to contact customer service to call and cancel the subscription.  Which lead customers to the customer review websites to publicly incinerate this business.  And, once the bad reviews are out there in mass, it is almost always too late to recover.

When we asked the business broker if he was aware of this situation, I found his answer humorous: "yes, the founder is aware that he is using 'aggressive marketing' tactics".  That was an understatement.  He would have been a lot closer by saying "suicidal marketing" tactics!!

MORE EXAMPLES

Here are a few more examples of overly aggressive marketing tactics we have seen:

  • Adding Better Business Bureau and eTrust certificates to their website, when in fact, they were not approved or highly rated by those services.  Flat out lying.

  • Keeping the hundreds of positive customer reviews published on their website, and curating out the thousands of negative customer reviews.  Dude, time to stop the presses and figure out why you are getting so many bad reviews in the first place.

  • Having their friends manipulate customer reviews on third party websites.  On a Monday, they had 50 only negative reviews published, and when we brought it to their attention, by Tuesday, there were 300 positive "fake" reviews added on the same site.

  • Not disclosing to their customers, pre-order, that products were being shipped from overseas, and that could result in 30-40 day delivery times.  Resulting in thousands of disgruntled customers trying to track down what they thought were lost shipments (many of which being missing gifts during Xmas season).

  • Selling a completely "snake oil" type of product, claiming certain benefits of the product that were not scientifically supported, and using fictitious before and after photos to enable the sale.

  • Firing away emails to their 500,000 person list, when the tactics used to build the list resulted in a very poor quality list only converting 0.01% of such customers into sales (1/100 of what it should be), and pissing off 500,000 people each week with unwanted emails in the process.

  • Selling prescriptions of certain hormone drugs to be used in off-label types of ways (e.g., weight loss in men), when the hormone was originally designed for other purposes (e.g., fertility in women).

  • Saying they were featured in major publications in their industry, when in fact, they simply bought advertising space in those magazines and did not have a featured editorial article.

  • Having a shopping cart funnel flow that tried to upsell customers additional products at seven different times during the purchase process.  Not illegal, but certainly ill-advised and abusive to the user experience.


Any of these tactics sound familiar in your own businesses??  If so, time to stop using strategies like these.  And, time to start building your business in more credible and customer-first ways.

WHY "AGGRESSIVE MARKETING" WILL KILL YOU LONG TERM

I know how hard it is to drive initial customers for your business.  But, if you need to resort to tactics like the above, yes you are helping your short term sales, but you are slicing your long term throat in the process.  Once bad customer reviews are out there, it will be near impossible to attract new customers.  Once investors learn these questionable tactics are being used by you, you will lose credibility in their minds, and they won't want to invest in your business.  And, once your customer funnel and access to capital dry up, there goes your business, right down the drain.

CLOSING THOUGHTS

As I have said in the past, with startups, perception often outshines reality, with many entrepreneurs doing the "smoke and mirrors" dance trying to get the attention of potential customers.  But, there is a very fine line between "stretching the truth", and flat out lying, or being overly aggressive with your marketing efforts.  So, if you are thinking about doing it, don't!!  As it will eventually come back to bite you in the ass.  A snake oil you certainly don't want coursing through your veins.


For future posts, please follow me on Twitter at: @georgedeeb.


Monday, January 22, 2018

Lesson #286: Want to Sell More? Keep Your Mouth Shut!

Posted By: George Deeb - 1/22/2018

I have written dozens of useful how-to lessons for driving sales , but perhaps none is more important than this one.  This is the day th...



I have written dozens of useful how-to lessons for driving sales, but perhaps none is more important than this one.  This is the day that you learn that driving sales has very little to do with what YOU have to say.  And, it is everything to do with what YOUR CLIENT has to say.  The magic sauce to closing the transaction is knowing how to ask probing questions, sit back and LISTEN.  Keeping your mouth shut is typically a really hard concept for a salesperson to grasp.  But, if they do, jewels of insights and real pain points of your customers will quickly surface to the top the more THEY talk.

YOUR PRODUCT IS LESS IMPORTANT THAN SOLVING PAINPOINTS

A salesperson’s first instinct is to pull out a demo of their product and start talking about all the bells and whistles built into the features and functionalities of that product.  [Insert Yawn!]  First of all, you never lead with the “what”, you always lead with the “why” your product can help them to drive more revenues, cost savings, customer experience improvements or whatever.  But, more importantly, you should never blindly open the pitch until you know exactly what your client’s pain points are.

IDENTIFY YOUR CLIENT’S PAINPOINTS

In order to learn your client’s pain points, you have to start by asking them what they think their pain points are.  In some cases, the client’s will know exactly what they are trying to improve in their business, as it relates to your product.  But, in many other cases, your client will not even know they have a problem, and you will need to educate them on the problem they have.  But, be sensitive to the fact many customers will not want to admit they have a problem, keeping their cards close to their chest for negotiating advantages.  So, it is up to you, to tease it out of them.

ASK PROBING QUESTIONS

A good salesperson knows how to ask the right questions, that will help them get to the meat of learning their client’s real pain points.  Sometimes you can tackle the question head on, like “tell me more about what you don’t like about your current product?”  Then, when ready, focus your pitch specifically around those elements they most care about.

But, sometimes you need to get to the answer through the back door, instead of the front door.  Maybe questions like “can you tell me more about your conversion rate you are seeing with your current tool, as I can help you benchmark that to what I am seeing with our other clients”.  That one question may go in many directions: (1)  they may not know their conversion rate (pain point #1); (2) they will certainly be curious what their peers are achieving, in comparison to themselves (pain point #2); and (3) any smart manager will want to learn how to improve their business if they are lagging behind (pain point #3).

Either way, the more probing questions you ask, the more intelligence you gain to craft a perfect pitch that exactly meets your client's needs, and the more learnings you can pass back to the product development team, for them to build additional features into your product, that can help next year's upsell with that client.

A CASE STUDY

I was working with a social media listening company.  This was a relatively new industry, compared to old school market research based on human focus groups. The sales team needed to help educate and entice their clients with questions like: (1) did you even know you could glean market research intelligence from social media; (2) would you be interested in listening to billions of social media conversations, to bubble up the three most important insights your customers are saying about your brand, versus asking the 100 people in face-to-face focus groups with expensive travel costs to ten different cities; and (3) did you know you are spending $1MM a year on traditional market research, and we can get you 10x better insights for only 10% of the price?   Not once did I say: look at this cool feature or functionality of our product, or pull out my demo.  You get to that later, after they are already drinking the Kool Aid at the strategic, higher level, and then you set the hook with the product.

CLOSING THOUGHTS

If you jump right into pitching your product, your odds of closing the sale are going to materially decrease.  Why?  Because you have no idea yet, what your client actually needs.  I argue you should not even pitch your product at all in the first meeting.  Build a relationship with them first, asking the key questions, learn their pain points, and THEN set up a second meeting that specifically addresses their most pressing needs.  This way, your odds of closing the sale will materially increase.  The biggest mistake most entrepreneurs have is having “diarrhea of the mouth”, when it comes to peddling their product.  All that does is put your customers to sleep in that first meeting.  And, that first meeting is the most important, to making sure you get the next meetings and the sale!  So, the next time you want to open your mouth in a first sales meeting—it better be asking questions and not pitching products.


For future posts, please follow me on Twitter at: @georgedeeb.



Wednesday, January 10, 2018

Lesson #285: How to Recruit & Retain Rockstar Talent

Posted By: George Deeb - 1/10/2018

You have heard me preach over and over again how great teams build great businesses.  That I would rather invest in an A+ team with a B+...



You have heard me preach over and over again how great teams build great businesses.  That I would rather invest in an A+ team with a B+ idea, than a B+ team with an A+ idea.  Well now, you can learn exactly how to recruit and retain rockstar talent for your business.  My close colleague Jeff Hyman, the Chief Talent Officer at Strong Suit a Chicago-based executive recruiter than specializes in VC and PE backed companies, just published a new best selling book called Recruit Rockstars--The 10 Step Playbook to Find The Winners and Ignite Your Business.  It was like everything that was in my head on this topic, just magically found itself in print in Jeff's must read book.  Jeff was kind enough to let me share some of his wisdom with you in this Red Rocket post.

THE 10 STEP PLAYBOOK

First of all, here is a good summary of the book, featuring the 10 Step Playbook for hiring rockstars.  It compares what most recruiters do, and what rockstar recruiters do.  Notice the key steps from starting with setting up an upfront scorecard for what will make a great candidate, focusing on the candidates with the right DNA, taking candidates for a test drive, paying special attention during onboarding and pruning mis-hires within the first 60 days, to name a few.
APPROACH RECRUITING LIKE A MARKETER, NOT A RECRUITER

I especially liked the section that said recruiters need to entirely change their mindset in terms of how they approach recruiting.  Recruiting talent for your business should be no different than the marketing tactics you would use to attract new customers for your business.  So, put on your marketing hats and figure out how you are going to build a great "employer brand" in attracting the best talent for your business.
RETAINING ROCKSTARS IS JUST AS IMPORTANT IS HIRING THEM

Here is a quick excerpt from Jeff's book on the importance of retaining your rock stars once hired, and how exactly to do that:
_______________

THE ALL-IMPORTANT FIVE CS

"After hiring a Rockstar, the real work begins—getting the most out of them. I’ve studied and tried countless leadership styles. I’m convinced that authenticity wins—be yourself. But ensure that you provide what I call the five Cs to your Rockstars. They value these more than treadmills, ping pong tables, and notoriety.

CHALLENGE

First and foremost, provide them with interesting work. Give them customer problems to solve and a variety of people to deal with. Ask them to figure out how to make things faster, cheaper, and better within the organization. Countless studies show that challenge is the most important factor to job satisfaction for Rockstars, ranking even higher than money.

CAREER PATH

Rockstars are not only interested in their current role, but in their next one. They want to understand their likely career advancement and progression. That doesn’t necessarily mean an annual promotion. It can include lateral moves to broaden skill sets or working in a different geography. You can also say, “Here are some potential options for what might come next. I can’t promise them to you today, but if you do an outstanding job in this role, in a year, here are the kinds of things we see someone like you doing.”

The average new hire will work with at least fifteen companies during their career. The average tenure at a company is two years. So, if you can keep a Rockstar aboard your “train” for longer than that, you’re doing well. Go ahead and tell them, “My hope is to make this the best job of your life. If I do that, you’ll likely stay with us for a sustained amount of time. My expectations are high, but they’re realistic. My job is to get the best from you and provide the most fulfilling
job you’ve ever had.”

There’s no need to have the career discussion more than every six months, but you need to understand their aspirations and how they evolve over time. That way, you can begin to think about their advancement and what other roles might make sense for them. Provide it before some headhunter does.

Part of career progression entails succession planning, so that when you experience a departure, you have a potential successor identified. The best companies in the world often have a successor in mind for every role; that way, if someone leaves, they have a replacement named by the end of the day. The injury-riddled occupation of football has addressed this issue with the motto, “Next man up.” Be prepared because you never know when a role will need to be refilled.

Bear in mind this will sometimes mean promoting a Rockstar who’s not quite ready for the next step—you can do so on an interim basis. This is often better than taking the chance with an outside recruit, who would come with risk and could be the reason your Rockstar departs when passed over for the role. Always search inside first; at the very least, when considering outside candidates, run all viable internal candidates in parallel through the same fair and objective process.

CANDID COACHING

Most Rockstars respond well to candor, because they have an insatiable need to improve their performance. They recognize the path to promotion, to taking your job, and the CEO role perhaps one day, is to continually improve. To get better, they need and crave your feedback. So, provide it frequently. Ban the annual review; your Rockstars hate it as much as you detest cramming to write those missives over Christmas week. Instead, implement a monthly or quarterly coaching cycle. Find just two or three messages—not the laundry list given by most managers—that you want to reinforce, give specific examples, and then watch for improvement. When you catch them doing something right, reinforce it by letting them know you noticed and by recognizing them publicly if possible. Your two or three things should be tied to the skills they need for their next career move.

A powerful yet underused tool to help you give candid feedback is the Socratic method. Ask a few simple questions. “How do you think the (meeting/product launch/etc.) went? What could you have done differently? What could have gone better?” Rockstars are often their own toughest critic. Often, they are aware of what could have gone better or what they could have done differently. You can say, “What can I, as your manager, do next time to make sure your performance is better?”

Rockstars appreciate a work environment where candor, or a debate-and-align structure, is valued. This structure supports productive disagreements focused on the idea, not the person. Once a decision is reached, regardless of whether the group agreed or the leader reached a decision, everyone agrees to align behind that decision.

CONTACTS

Open your personal network—including your LinkedIn network—to your team. Introduce them to mentors outside the organization. This is especially important if yours is a small company where there just aren’t many people for them to learn from. You might know people who would be great role models for your Rockstars. Some managers won’t do this because they want to keep their Rockstar a secret, but when you introduce them to people who can broaden their knowledge, they will be grateful. And that increases loyalty.

COMPENSATION

Compensation isn’t everything, but it’s something. I’ve found that more important than the fixed base salary, however, is the variable upside. Rockstars respond well to a challenge, and they respond well to currency tied to upside performance. Lay out specifically how they earn it. Be clear with what percentage they can earn and when it will be paid out. And don’t change the rules halfway through the game.

Rockstars don’t respond well to black-box, or subjective, variable compensation. No matter how well they do, they don’t know what they’ll earn. That’s not motivating, and so you’re wasting your money and frustrating your top performers. Avoid capping your variable compensation. If they can deliver three times what you expect them to deliver, they should receive a meaningful variable compensation payout.

Perhaps my greatest frustration with regard to compensation is that so many leaders apply the “peanut butter” approach. They spread money around, approximately the same to all employees, in an effort to keep the peace. Instead, use differentiation, the concept of not treating everyone equally, to separate Rockstars from B- and C-Players. It means promotions, titles, and public recognition for great performances. It means fair compensation tied to performance. So rather than giving everyone 2 to 5 percent raises, give 20 percent raises to the ones who deserve it. And yes, that means you’ll fund it by giving no raise this year to many. And those C-Players may choose to leave because of it. And that’s okay."

______________


So, as you can see, there is a lot of terrific wisdom in Jeff's new book.  It is a must-read if you going to build really great teams for your business, as there are a lot more how-to details in the book than are shared in summary in this post (here is the link to the book on Amazon).  Thanks, Jeff, for allowing us to share this gem with our Red Rocket blog readers.

For future posts, please follow me on Twitter at: @georgedeeb.


Friday, January 5, 2018

The Pros and Cons of Hiring a Clone of Yourself

Posted By: George Deeb - 1/05/2018

Come on, we have all thought it as entrepreneurs, at one point or another in our careers: “I just wished I could clone myself in findin...




Come on, we have all thought it as entrepreneurs, at one point or another in our careers: “I just wished I could clone myself in finding new employees for my business. Nobody works harder than I do. Nobody is as smart as I am. I don’t trust anybody to make decisions or manage teams better that I do.”  Sound familiar? But is "cloning" yourself really the right solution for your hiring goals? There are clear advantages and disadvantages to a strategy like this, so you will need to figure out if cloning yourself will help or hurt your business, based on your business’s specific needs. Read on.

Read the rest of this post in Entrepreneur, which I guest authored this week.

For future posts, please follow me on Twitter at: @georgedeeb


Wednesday, January 3, 2018

Lesson #284: How To Calculate Your Total Addressable Market Size

Posted By: George Deeb - 1/03/2018

I have written many posts about the importance of determining your industry size for strategic planning or investor pitch purposes.  Bu...



I have written many posts about the importance of determining your industry size for strategic planning or investor pitch purposes.  But, determining your industry size is not always easy, and more importantly, determining your total addressable market (which I will define later), is even more important and an even more nebulous calculation.  So, here is everything you need to know to make sure you are correctly calculating your total addressable market and going after the biggest total addressable market you can (which will attract more investors for your business).

THE DIFFERENCE BETWEEN INDUSTRY SIZE AND ADDRESSABLE MARKET

In this lesson, let's use the example that we are selling social media marketing software into small businesses.  If you go to Google to search for "marketing software industry size", you will stumble on many industry research reports written by professional research firms, that estimate the marketing software industry was approximately a $37BN market size in 2017, on a global basis.

Many entrepreneurs will just stop there, and say they are serving a $37BN industry.  But, are you really?  First of all, you are not selling globally today, you are most likely only selling in the U.S.  And, with the U.S. around 30% of the global market, your market size just cut to $11BN.  And, you are only serving social media software, not other types of marketing software.  So, estimating that social media only makes up 20% of all marketing software, that means your market has just cut down to a $2BN market.

But, it doesn't stop there.  Perhaps half of the social media marketing software business is for managing free social communications, and the other half is focusing on managing paid social media advertising campaigns.  Let's say, you only do the latter, so now your industry size is down to $1BN.  But, remember, we only serve small businesses, not large enterprise-scale corporations.  With small businesses comprising 50% of the U.S. economy, now you are down to a more realistic $500MM total addressable market size.

Furthermore, assuming there will be plenty of big competitors going after this exact same space, it is unlikely that you will ever drive in excess of $100MM in revenue, with a hefty 20% market share in this space.  So, don't show your revenues ever getting larger than that . . .  unless you broaden your product offering or expand your target client base or take your business global.

THE DIFFERENT WAYS TO CALCULATE TOTAL ADDRESSABLE MARKET

There are a few different ways to calculate total addressable market size.  The above example was a TOP DOWN look, starting with the overall industry size and paring it back to the market you are actually serving.

A second way to calculate it would be BOTTOM UP.  That would start with actual data from what you are actually selling today, and grossing it up for your potential future selling efforts.  Let's use this same example as above, and take a bottoms up look.

Let's say you have been in business for a year and already have $1MM in revenues at a selling price of $25,000 per customer (serving 40 customers today).  Let's say there are 16MM small businesses in the U.S., but only half of those are B2C marketing driven companies (taking us down to 8MM B2C small businesses).  But, only 10% of them would ever be able to afford a software like this, since the average small business only does $5MM in revenues.  So, there are 800,000 potential customers over time.  Of which, you would not be able to get more than 20% market share, so 160,000 potential clients of yours.  So, that suggests a total addressable market of $20BN (or $4BN to you with a 20% market share), as your current $25,000 selling price.

A third way to calculate total addressable market would be the value-created model.  That says your solution is going to help your customers drive additional revenues, or save future costs, and they will share a portion of that with your business.  So, let's say there is $30BN in social media advertising spent every single year in the U.S., half of that by small businesses, or $15BN.  Let's say your software can save them 10% on their marketing expense, with better efficiency from your tool.  So, $1.5BN in value created.  And, let's say you sell them on giving 10% of those savings to you, creating a $150MM market opportunity for you and your competitors (and a $30MM revenue opportunity for you, assuming you get a 20% market share).

NOW COMES THE SANITY CHECK

We tried to calculate the total addressable market in three different ways, and got three completely different answers.  Top down suggested $500MM, bottom up suggested $20BN, and value-created suggested $150MM.  We obviously were too aggressive with our bottom up thinking.  It is not rational for us to serve a $20BN market in bottom up analysis, when the overall marketing software industry in top down is only $11BN.

So, I would go back to the drawing board on bottoms-up, or ignore it altogether.  On the second try, I would cap it based on how many sales people I can afford to hire in the next five years.  So, if we have 20 sales people in year five, each doing $1MM in sales each, that suggests your business is $20MM in size and serving at least a $100MM market.  If not more, as you will most likely not have a 20% market share as early as your fifth year.  Maybe you only have 5% market share by then, and the market is really $400MM in size.

That leaves us with two reasonable numbers with the top down and value-created analyses.  But, two thoughts here.  First, I would always lean towards the lower number, to be conservative, or the $150MM value-created number in this case.  And, second, I would also lean to a bottoms-up or value-created number, over a top down number, as those are more real based on known data points for your business, as opposed to pie-in-the-sky estimates from the industry research created by an analyst you don't know is any good, or not.

WHAT DOES THIS ALL MEAN FOR YOUR  BUSINESS & FUND RAISING

So, hopefully, you know have a better understanding on how to calculate total addressable market for your business.  Stop embarrassing yourself with inflated numbers trying to impress investors.  They will be more impressed with your more scientific, data-driven approach to a more conservative and realistic number.  So, put that number in your investor presentations.

But, in all cases, venture investors are trying to build $1BN companies, so if you can't reasonable build them $100MM revenue company that can be sold at a 10x revenue exit multiple, you might need to either expand your product offering to attract more revenues, or know that your business will most likely not attract venture investor attention.  So, in this case, the value-created model only gets us to $30MM in revenues.  That will not be enough.  Back to the drawing board, if venture investors are what you are looking for.


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